BRUSSELS, May 7 (Reuters) - Italy's huge debt is expected to grow further this year and next as the country's growth remains sluggish, the European Commission said on Tuesday in quarterly economic forecasts that could reignite a dispute over Rome's budget.

Brussels cut its already gloomy outlook of Italy's economy, which it now says is set to grow by 0.1 percent this year instead of the 0.2 percent it predicted in February. The country grew by 0.9 percent last year.

The downward revision confirms the general worsening trend for the wider euro zone economy, which is expected to slow more than previously estimated. But Italy remains the country with the lowest growth in the bloc, far below the euro zone's 1.2 percent expansion forecast for this year.

The Commission said Italy's sluggish growth will weigh on the country's public finances, with both debt and deficit expected to climb far beyond what is allowed by EU fiscal rules.

Although no EU decision over possible disciplinary moves is expected before European elections on May 23-26, the new estimates could increase market pressure on the Italian government, which is already plagued by infighting.

With no policy changes by the eurosceptic Italian administration, Italy's debt would grow to 133.7 percent of gross domestic product (GDP) this year, and peak at 135.2 percent in 2020, the EU executive estimated.

Euro zone countries with a debt above 60 percent of GDP are required to gradually reduce it, but Italy's debt has been growing since last year.

With a debt ratio second only to bailed-out Greece, Rome has already the highest interest expenditure in the bloc with 3.7 percent of its output paid to service debt last year.

As yields dropped slightly after a deal with Brussels over the Italian budget in December, interest expenditure is forecast to drop to 3.6 percent of GDP this year, before rising again in 2020.

With no changes in the government's spending policies, the country's deficit is also set to grow to 2.5 percent of output this year and to climb to 3.5 percent in 2020, beyond the 3.0 percent ceiling set by EU fiscal rules.

The structural deficit, which excludes one-off items and the effects of the business cycle, is also expected to significantly worsen. This indicator is crucial in the EU assessment over countries' compliance with fiscal rules.

MORE JOBLESS Despite worsening public finances, caused by lower growth and higher welfare spending, employment is expected to fall, the Commission predicted, in a blow to the Italian administration's flagship policies aimed at reducing joblessness.

Employment is set to drop by 0.1 percent this year, while the unemployment rate will climb to 10.9 percent this year and to 11.0 percent in 2020, as government jobless subsidies are "likely to induce more people to officially register as unemployed," the Commission said.

The Commission also said investments would fall by 0.3 percent this year, after a 3.4 percent increase in 2018. Italy's primary surplus, which excludes interest payments, is expected to ease.

Italy's outlook could worsen if yields rose again, but would improve if spending was reduced and a planned rise of sales tax was applied next year, the Commission said. (Reporting by Francesco Guarascio; editing by Robin Emmott)